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When Marsh & McLennan Cos. Inc. announced in March 2004 that it had nominated a shareholder-backed candidate to its board, the move sent shock waves through the corporate governance community. The decision was the end of a battle waged by the California Public Employees’ Retirement System (CalPERS) and three other heavyweight institutional investors that wanted to see more independent directors on the insurance company’s board. Their campaign began in December 2003. Prompted by allegations of market timing at Putnam Investments, a Marsh subsidiary, the institutional investors announced that they would sponsor a shareholder resolution seeking access to Marsh’s proxy statement in order to nominate a director. Companies historically have paid little heed to such initiatives, but this time was different. New York-based Marsh contacted the pension funds to negotiate. Four months later, and just before the annual shareholders meeting, the funds withdrew their proposal after Marsh agreed to nominate their director. The funds’ choice, Zachary Carter, an ex-federal prosecutor and partner in Dorsey & Whitney’s New York office, was elected in May. “It’s the single most important corporate governance event of the year,” said Nell Minow, editor and co-founder of The Corporate Library, a corporate governance research group based in Portland, Maine. “It shows that shareholders will be playing a role in determining board makeup whether or not the Securities and Exchange Commission (SEC) adopts the proxy-access rule [a proposal before the agency that would give shareholders certain rights to nominate directors on the company proxy].” The market steps in There’s a new corporate governance sheriff in town, and it’s the market. In 2003, corporate governance was all about the regulators. General counsel had their hands full with the Sarbanes-Oxley Act, the most sweeping set of corporate governance reforms in some 70 years. In 2004, in place of Congress and federal and state regulators, the market stepped in. Institutional investors wielded newfound power to force radical changes at companies. Tough rules went into effect for listed corporations on the New York Stock Exchange (NYSE) and Nasdaq that mandated independent directors and other measures designed to get public company boards out from under the influence of management. The ratings agencies downgraded one major corporation, the Royal Dutch/Shell Group of Cos., based on governance concerns. And businesses themselves began to embrace corporate governance, adopting reforms above and beyond exchange and federal regulations. “I’m seeing a major shift in attitude,” said Margaret Foran, a longtime governance expert who serves as vice president of corporate governance and secretary of New York-based Pfizer Inc. “Companies are really paying attention to corporate governance issues and are [adopting best practices] willingly, as opposed to just doing the bare minimum. Companies ‘get it’ now.” At the start of 2004, the proxy access rule stood front and center on the corporate governance stage. The proposal quickly faltered, however, in the wake of disagreements among the SEC commissioners who, at press time, still hadn’t decided whether to adopt the rule. Still, it galvanized investor groups “who were injected with a new energy around the issue [of giving shareholders a prominent role in picking directors],” said G. Penn Holsenbeck, associate general counsel and corporate secretary at tobacco and food conglomerate Altria Group Inc. The first sign of this momentum came in early March, when 43% of shareholders of The Walt Disney Co. withheld their vote for Chief Executive Officer Michael Eisner’s re-election as chairman of the board. The vote was the result of a campaign spearheaded by ex-directors Roy Disney and Stanley Gold and supported by a number of institutional investors. The board responded by replacing Eisner as chairman of Disney with former U.S. Senator and Disney director George Mitchell. (Eisner remains a director and CEO.) CalPERS, the largest public pension fund in the United States, had another prominent corporate governance win last September. In November 2003, after allegations arose that Putnam allowed illegal trades in some of its mutual funds, CalPERS and a California teachers pension fund fired Putnam, which managed $1.5 billion of their holdings. But after reaching a groundbreaking deal with Marsh in early 2004 over the nomination of a shareholder-backed director, the funds were able to get Putnam to agree to review its proxy-voting policy on executive compensation, as well as disclose more information on investor fees and portfolio managers’ compensation. In return, Putnam will be allowed to compete for CalPERS’ business again (although as of press time it had yet to be rehired). The Corporate Library’s Minow said the deal is the “Mount St. Helens” of the investment community. “It’s the first time that money managers have responded to demands by investors,” Minow said. (In April 2004, Putnam settled an SEC enforcement action and agreed to pay a $50 million civil penalty and $5 million in disgorgement.) Pressure for independence In May, another powerhouse investor, Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), successfully pressured credit card issuer MBNA Corp. to add two new independent directors to its board. Linda Scott, TIAA-CREF’s director of corporate governance, said that Wilmington, Del.-based MBNA has also agreed to a supermajority of independent directors, with the result that eventually all but one of the board members of the credit card lender will be independent. She said that the fund was able to bring about changes at a number of other businesses as well, although she declined to name them. “Companies are increasingly responsive to shareholders on issues,” Scott said. Even the independent credit-rating agencies climbed on the corporate governance bandwagon. Royal Dutch/Shell earned the dubious distinction of being the first (and so far only) company to see its credit rating cut because of corporate governance concerns, by Fitch Ratings and Standard & Poor’s; the latter described Royal Dutch/Shell’s governance as “weak” and “complicated.” The energy company announced a major overhaul of its corporate governance structure in October, saying it will combine its separate Dutch and English companies into a single group, to be called Royal Dutch Shell. “The regulators respond first [to scandal], and the market responds later,” said Minow. “But the market responds more powerfully and more effectively.” Exchanges’ standards in place This past year, public companies also felt the influence of two other important market players, NYSE and Nasdaq. The exchanges’ new corporate governance standards for their listed companies kicked in over the course of 2004, setting out criteria to get rid of rubber-stamp boards controlled by powerful CEOs. Under the new NYSE regime, boards must now have a majority of independent directors, as defined by strict bright-line tests: For instance, an independent director must be free of any immediate family relationship or material business or professional relationship with the corporation. Boards must also have compensation, audit and nominating/corporate governance committees, all of which must be composed solely of independent directors. Some observers downplayed the impact of the new rules, saying they only institutionalized best practices already in place at many companies. A recent survey conducted by D&O Advisor, a sister publication of The National Law Journal, bolsters this perception, at least at the largest companies: The survey found that the average Fortune 50 board has close to 82% independent directors. But corporate governance experts say that the new standards are significant. “They dramatically shifted the balance of power between boards and management,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. In particular, he said, the new requirement that boards have an independent nominating committee makes an enormous difference. “Before, the CEO would decide who was on the board and who wasn’t,” Elson said. “If the CEO put you on the board, it certainly is much more difficult to be independent.” Requiring boards to schedule separate meetings just for the independent directors also makes for a more balanced board, Elson said. “It allows directors to talk among themselves without management present,” he said. But with power comes responsibility. Bart Schwartz, deputy general counsel and corporate secretary for Marsh, said the new stock exchange standards are also rife with oversight functions that have not traditionally been part of a director’s duties-for example, NYSE’s new rule that the audit committee must assist the board in overseeing the company’s compliance with the law. An apparent failure of oversight by the board of Hollinger International Inc. was also a theme in the August report by former SEC Chairman Richard Breeden on corporate governance problems at the Chicago-based newspaper group. More emphasis on board oversight is “sort of in the air,” Schwartz said. But he said the duty of oversight is fundamentally different than the duties of care, loyalty and good faith required of directors. Where the latter three duties are fairly easy to discharge, since they apply only when a director makes a decision, the duty of oversight “applies all the time,” he said. “It’s a scary thing if you think about it, because how can directors be sure that they’re not missing something?”

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